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A Pension for Change

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	A Pension for Change Michael T. Owyang is an economist and Abbigail J. Chiodo is a researcher associate at the Federal Reserve Bank of St. Louis.

American workers are more mobile than ever, and evidence shows that when employees change jobs, they take their pensions with them. In this article, we will discuss two retirement savings options:

• defined benefit (DB) pensions, which offer a predetermined payoff after a certain tenure, and
• defined contribution (DC) plans, such as 401(k)s.

The accompanying figure shows that during the last two decades, the portion of workers with a DB pension fell from 85 percent (1983) to 40 percent (1998). Overall, pension coverage has fallen; however, of the portion of workers with some kind of retirement program, the fraction of those with a DC plan has jumped from 60 percent (1983) to 79 percent (1998). What is causing this phenomenon, and what does it mean for today's workers?

The typical DB pension is structured so that its value spikes at a predetermined year. When workers retire, they receive an annuity that usually depends on both their final salary and years of service. Economists have hypothesized that because DB pensions are not portable, they encourage workers to stay in their current jobs until they are eligible to collect full retirement benefits.

Unlike the spikes seen for DB pensions, wealth accrual in DC plans is smooth and age-neutral. DC plans allow workers to determine the rate at which their retirement benefits accumulate, with many employers matching some portion of the employees' contributions.

What has caused the migration from DB pensions to DC plans in the last 20 years? Some researchers suggest that while legislation has played a part, economic explanations also are prevalent. Recently, the value of DB pensions as implicit contracts between firms and workers has been greatly reduced. Some studies show:

1) DB pensions are more common in larger firms (e.g., manufacturing) and the proportion of workers employed in these industries has declined.

2) Changing technology may create a volatile demand for skilled workers, giving these workers lower employment tenures.

What does this imply for the average worker? The portability of DC plans and their unlimited accrual potential might lead to later retirement dates.

In another study, researchers estimated the likelihood at each age that full-time employees voluntarily leave their jobs and retire fully. They predict that more than 80 percent of workers with a DB pension would retire by age 65; if those workers have a DC plan instead, only about 60 percent will retire by age 65. All other things equal, the researchers estimate that (on average) a worker with a DB pension retires 23 months earlier.

Years ago, workers expected to spend their entire careers at a single firm. Perhaps because our current economy is based more on retail and services, rather than manufacturing, today's workers expect to change jobs frequently. Old-style DB pensions are no longer viable as retirement options, because (on average) today's workers will not stay at their employers long enough to receive the maximum payoff. Consequently, DC plans are replacing DB pensions. This gives workers more employment flexibility, but may also lead workers to postpone their retirement by almost two years.

This article is based upon the following research article, "Not Your Father's Pension Plan: The Rise of 401(k ) and Other Defined Contribution Plans," by Leora Friedberg and Michael T. Owyang, which appeared in the January/February 2002 issue of Review.